More - not less – QE means this is not tightening

Some today will be disappointed that Mr Draghi is planning to taper the ECB’s QE from next April. But Neil Williams, Group Chief Economist at Hermes Investment Management, believes they shouldn’t be.

First, tapering means more, not less, QE, and even though he’s closing the tap a notch in April, the ECB’s liquidity sink is still filling up. By tapering its monthly asset purchases from €80bn down to €60bn, he is still looking to inject an extra €540bn in QE. To put this into perspective, this easily surpasses in equivalent terms, the combined GDPs of Greece and Portugal for example.

Second, the nuance here is his growing support for fiscal support.

A lesson from Japan is that QE provides cash to lend, but cannot force consumers and firms to borrow. The euro-zone looks to be halfway down the Japan route. It too may be running QE and negative rates, but has yet to loosen the fiscal reins.

Yet, austerity has pulled down its budget deficit from 6¼% of GDP in 2009 to 2% - below the 3% Maastricht test for EMU. We suspect this makes it easier presentationally for fiscally-prudent Germany and the ECB to ‘turn a blind eye’ to profligacy by the higher-debt members needing to maximise growth. With Greece losing a fifth of its real GDP since austerity and Italy/Spain running 36%/43% male-youth unemployment rates, reform fatigue - and populist parties - are building.

‘Helicopter money’ is considered a next step, via targeted fiscal give-aways. This would go some way to aligning the euro-zone and Japan with the faster-growing US and UK, whose net fiscal positions have loosened the most in the long run. Together with on-going monetary stimuli, this would raise the chance of keeping the euro down to avoid deflation. A hitch is the absence of a region-wide fiscal agency. This precludes a unified giveaway akin to the US’s tax-rebate cheques ‘helicopter dropped’ to consumers in 2001 and 2008.

But, this could still be done nationally, perhaps in a coordinated way, supported (by actions if not words) by the ECB’s bond buying. Given the ECB’s concern expressed last the spring about “political risk” (reform-reluctant populist parties) potentially contributing “to contagion and re-fragmentation” of the zone, it should at this lower deficit ratio, be seen as the lesser of ‘two evils’. Reform pledges could even become back-end loaded to allow growth to breathe and avoid credit downgrades.

Either way, despite an improving periphery, it will take years before the converging countries can reclaim their GDP lost - with Italy and Greece’s real GDP, on a net basis, still yet to rise with the euro.

Meantime, with 2017 such a highly-charged political year in Europe, any contagion, unlike 2008-09, is increasingly likely to be political rather than financial.